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Why We Need to Look Past the Government's Gung Ho Narrative on India's FDI Dilemma

Policymakers within the government policy sphere are building a narrative that the decline in India's FDI is temporary – but this gung-ho narrative ignores the systematic and policy failures behind the decline in FDI. In this context, four issues deserve attention.
Representaional image. Photo: flickr.com/Wen-Yan King/CC BY-NC-SA 2.0 DEED

Foreign direct investment (FDI) is considered one of the most important indicators for assessing a country’s global competitiveness. In the view of changing global geopolitical realities and global supply chain realignment(s), India finds itself at a critical juncture, struggling with the ramifications of its suboptimal FDI performance vis-a-vis the China-plus one strategy.

A sharp decrease in FDI inflows in the country has received considerable attention in policy debates. The decline in FDI is witnessed both in terms of absolute value and the share of the country’s gross domestic product (GDP).

According to the Department of Internal Trade and Promotion, FDI has declined from US$36.7 billion (April-December 2022) to US$32 billion (April-December 2023), thereby exhibiting a decline of 13%.

A steep fall in FDI is noticeable in crucial sectors such as automobiles, infrastructure, construction, computer hardware and metallurgy.

The contraction in FDI inflows in the country is worrisome given the optimistic forecasts of India’s economic growth by the International Monetary Fund and the World Bank.

However, policymakers and policy experts within the government policy sphere are building a narrative that the decline in FDI is merely a temporary phenomenon due to the global slowdown in mergers and acquisitions activities, monetary tightening in developed economies and FDI-led geopolitical competition.

But this gung-ho narrative largely ignores the systematic and policy failures behind the country’s decline in FDI. In this context, four issues deserve attention.

Also read: Precipitous Decline in FDI in Last Two Years of Modi’s Tenure

First, India still imposes several restrictions on FDI, notably in the form of government approvals, sectoral limits, lack of transparency and uncertainty in investment rules. These restrictions are evident in sectors such as multi-brand retail trading, defence, broadcasting content services and print media.

Furthermore, the Indian government implemented Press Note 3 in 2020, which restricts FDI from neighbouring nations such as Bangladesh, China and Afghanistan.

The rationale for imposing restrictions on FDI from these countries was national security concerns and to safeguard Indian firms from hostile takeovers, especially by Chinese firms during periods of economic fragility.

It is important to note that India rejected over 300 FDI applications from China since 2000. This reflects that Indian policymakers are facing an unviable dilemma between security and FDI imperatives.

Second, India terminated all its bilateral trade treaties (BITs) in 2016 in view of the increasing number of investor-state arbitrations. It introduced a new template for BITs to strike a balance between the rights of the state to regulate investment and protection for foreign investment.

However, the new template has experienced severe backlash globally owing to inherent policy flaws in many of its clauses.

The new template reduces the liability of the state and increases the bar for the investor to raise a claim under the BIT. Further, it presents challenges for foreign investors to take legal recourse to international arbitrations.

India’s attempt to negotiate new BITs failed to motivate countries to sign investment protection agreements. The absence of BITs has severely impacted India’s ability to attract international investments.

A study by Kotyrlo and Kalachyhin (2023) shows that the termination of BITs has led to a massive decline in FDI inflows from a country with which India terminated its investment treaties.

Also read: Why India’s Bilateral Investment Treaty Model Needs a Rethink

Third, the lack of coherence between trade and investment policies continues to be an area of concern for India under its Self-Reliant India initiative.

On the one hand, India is liberalising its FDI policy, but at the same time, it is increasing its import tariffs.

India’s trade policy under its Self-Reliant India Initiative has become inward oriented. The average import tariff on industrial products increased from 9.7% in 2014 to 14.7% in 2022.

High import tariffs not only undermine the country’s ability to mobilise export-oriented FDI in assembling operations, but also restrict its participation in global value chains.

A strong coherence between trade and investment is vital to attract trade induced FDI in the country.

Fourth, MNCs, as part of their China-plus one strategy, are looking for potential investment opportunities to diversify their supply chains. They consider Vietnam, Indonesia and Thailand to be more attractive investment opportunities.

The tax structure and corporate tax regimes are more favourable in Southeast Asian countries, which serve as catalysts to MNCs-led FDI. Indonesia, for example, has transparent rules and regulation to regulate corporate activities.

India is yet to offer a competitive policy framework that is at par with the Southeast Asian economies. This requires the overhauling of business policies and a tax structure to promote FDI.

Key policy reforms include rationalisation of corporate tax rates, goods and factor market reforms, resolution of liquidity concerns, and ease of doing business reforms for foreign investors.

There is a need to make FDI policy more lucrative before other countries steal our opportunity on the China-plus one front.

Finally, the onus for key policy and business reforms lies on states. The key issue in this realm is the absence of a coherent policy framework that facilitates foreign investment in the country.

There is a need to foster greater convergence between state and central FDI policies through the active participation of states in policymaking at the federal level. Thus, it is imperative to address the discrepancy among states in India when it comes to attracting FDI.

States such as Maharashtra, Karnataka, Gujarat and Delhi are able to attract the highest amount of FDI, but Odisha and Punjab on the other hand struggle to attract FDI, leading to investment-led regional economic disparities.

The growing disparity and inequality among states is another factor for states to adopt competitive FDI policies to attract investment. This can only be achieved if the Union government overcomes its policy stance of “confrontational federalism” and “political vendetta” to facilitate the participation of states in national economic policymaking.

Akshita Arora is an associate professor at BML Munjal University, Gurgaon. Surendar Singh is an associate professor at FORE School of Management, New Delhi. Views are personal.

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